Insuring your life

October 11, 2017

How much life insurance do you need?

By Deanne Gage

When buying life insurance, it’s important to take into consideration your annual income, debt and net worth.

Life insurance is something you don’t buy for yourself — you buy it for the benefit of others. When should you think about buying it? Certainly, when you get married, have children or have someone who is dependent on your income. Then the question is: How much life insurance do you need?

Take a common-law couple in their early 30s we’ll call Carly and Jack. They have been in a relationship for 3 years and recently purchased a $450,000 2-bedroom condo in a Toronto suburb. But what if Jack or Carly suddenly died? It currently takes both Jack and Carly’s incomes to afford their $2,300 monthly mortgage payments and condo fees. In the event that one spouse dies, the other could sell their home and downsize. However, in this particular case, the couple would like to avoid that hassle. So, the couple decided to get life insurance to protect their new home. That way, Carly or Jack would have the money to pay off their mortgage if something happened to one of them.

Is your employer-provided life insurance coverage enough for you?

Many people believe the coverage provided by their employer is sufficient. But let’s do the math. Your employer’s group insurer would likely pay your beneficiary three times your annual salary, at most. If you earn $70,000 a year, that’s $210,000. Let’s say you have a husband and two young children counting on that income for mortgage payments, daycare costs, education savings and day-to-day living expenses. It won’t take long for that lump sum to disappear.

How are life insurance premiums calculated?

So how much do you need? An insurance advisor will help you to fill out a needs analysis questionnaire to determine the appropriate amount, taking into consideration your annual income, net worth, debts and existing life insurance.

A general rule of thumb is you should be covered for at least 10 times your annual income, so if you earn $70,000, you’d be looking at $700,000 in coverage. But every individual situation is different and should be examined as such.

An analysis would determine what you need the money for, how much you need each month and how long you need it to last. Let’s take Jackie, a 33-year-old married mother of two. She has three goals for her insurance coverage:

Pay off her $300,000 mortgage.

Top up her two children’s registered education savings plans (RESP).

Replace her $60,000 income.

In simple terms, Jackie is looking at a $1-million policy. If she died, the money from her insurance could be spent this way:

$600,000 (her annual earnings times 10) to invest to cover day-to-day expenses that her husband and children will incur over the years.

How term life insurance works

Term life insurance provides temporary protection for temporary needs. Specific terms usually range from one to 30 years, so it can be an excellent, affordable option for parents with young children. For instance, a $1-million, 30-year term policy on a non-smoking woman in her early 30s like Jackie could cost about $77 per month. For a man of the same age, it’s closer to $107. Experts recommend 30-year term policies for younger couples who are buying their first homes, are recently married and have significant debt. For couples in their 40s who have little debt and have almost paid off their mortgages, 10-year term policies might be sufficient. Couples can consider joint-term, first-to-die policies, which insure two people and pay out on the death of the first insured person.

Jackie and her husband Bob decided they needed a $1-million, joint first-to-die, 20-year term life insurance policy, with a monthly premium cost of $103. They thought about going with a $500,000 life insurance policy instead, but reconsidered at the last minute. With a significant mortgage to pay off, they wanted the security of knowing that in a worst-case scenario, they’d have that extra money for other needs.

In addition to providing affordable protection, term insurance also gives you some future flexibility. Most term insurance plans let you convert your term coverage to permanent insurance without having to answer any health-related questions. As long as your premiums are paid, your life insurance protection will stay in place for the rest of your life.

What kind of life insurance is right for you?

Bear in mind, term life insurance might not be the right fit for you. You need to look at your personal needs and current situation, the stage of life you’re at, and what you can afford.

Permanent life insurance provides guaranteed lifetime protection. Younger Canadians will find it more expensive than term. But your premiums remain constant, so at a certain point in your life it will be cheaper to pay for your permanent life insurance than it would be to buy additional term insurance.

Apart from term or permanent life insurance, you might find that universal life insurance is better suited to your financial needs. In most cases, it provides consumers with lifetime (or at least long-term) protection while at the same time making possible tax-deferred savings. Some universal life insurance products feature premium payments that remain constant over time, some require payments that rise over time and others combine both. Payments made over and above the cost of the insurance can be invested and your savings will be held on a tax-deferred basis.